AGNC Investment Corp (AGNCO) 2011 Q1 法說會逐字稿

Good morning.

My name is Nicole and I will be your conference operator today.

At this time I would like to welcome everyone to the American Capital Agency Corporation Q1 fiscal 2011 conference call.

All lines have been placed on mute to prevent any background noise.

After the speakers' remarks, there will be a question-and-answer session.

(Operator Instructions).

Thank you.

I would now like to turn the call over to Ms.

Katie Wisecarver to begin.

Please go ahead, ma'am.

Thank you, Nicole, and thank you for joining American Capital Agency's first quarter 2011 earnings call.

Before we begin, I would like to review the Safe Harbor statement.

This conference call and corresponding slide presentation contains statements that to the extent they are not recitations of historical fact constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

All such forward-looking statements are intended to be subject to the Safe Harbor protection provided by the Reform Act.

Actual outcomes and results could differ materially from those forecasts due to the impact of many factors beyond the control of AGNC.

All forward-looking statements included in this presentation are made only as of the date of this presentation and are subject to change without notice.

Certain factors that could cause actual results to differ materially from those contained in the forward-looking statements are included in the risk factor section of AGNC's 10-K dated February 25, 2011 and periodic reports filed with the Securities and Exchange Commission.

Copies are available on the SEC's website at www.SEC.gov.

We disclaim any obligation to update our forward-looking statements unless required by law.

An archive of this presentation will be available on our website and the telephone recording can be accessed through May 10 by dialing 800-642-1687 and the conference ID number is 58474355.

To view to Q1 slide presentation, turn to our website, AGNC.com, and click on the Q1 2011 earnings presentation link in the upper right corner.

Select the webcast option for both slides and audio or click on the link in the conference call section to view the streaming slide presentation during the call.

(Operator Instructions).

Participants on today's call include Malon Wilkus, Chairman, President, and Chief Executive Officer; John Erickson, Chief Financial officer and Executive Vice President; Gary Kain, President and Chief Investment Officer; Chris Kuehl, Senior Vice President and Mortgage Investments; Bernie Bell, Vice President and Controller; and Jason Campbell, Head of Asset and Liability Management.

With that, I will turn the call over to Gary Kain.

Thanks, Katie.

Good morning, everyone, and thanks for joining us.

A lot transpired during the quarter including the unrest in the Middle East, the horrible earthquake and tsunami in Japan, the continued concerns surrounding the European sovereign debt, and plenty of discussion relating to QE2, monetary policy, the economy, and of course, GSE Reform.

That said, agency mortgages performed pretty well and interest rates were surprisingly stable.

With this as the backdrop, let's review AGNC's performance for the first quarter.

First, GAAP net income totaled $1.48 per share.

Now if we exclude the $0.18 of other investment income, that leaves $1.30 per share of what many of you term core income versus the $1.26 per share last quarter.

The $1.30 per share is our strongest quarter since our inception by this measure, despite the fact that average leverage was lower during the quarter.

Taxable net income was $1.68 per share.

Taxable income was higher than GAAP net income in Q1 as some of the unrealized gains that were included in our Q4 2010 GAAP income were realized and were thus captured this quarter for tax purposes.

Our undistributed taxable income increased during the quarter by $16 million to $55 million as our taxable earnings exceeded our dividend, and again this is despite the significant amount of equity that we raised during the quarter.

As of March 31, this equated to $0.42 of UTI off our ending share count of 129 million shares.

Book value per share increased 7% or $1.72 per share to $25.96 during the quarter.

Book value benefited from the significant accretion associated with our equity offerings during the quarter and to a lesser extent, the outperformance of both 15 year and higher coupon fixed-rate mortgages as well as IOs.

Our economic return, which is the combination of dividends plus the increase in book value, totaled 13% for the quarter or 52% on annualized basis.

Now, as you can see on the next slide, our mortgage portfolio totaled $28 billion as of March 31 and leverage at quarter end was around 7.6 times.

Average leverage during the quarter was down a complete turn to 7.4 times.

This was driven in large part by the typical delays related to settling new acquisitions associated with the capital raises.

Finally, AGNC raised about $1.7 billion in new equity in two accretive follow-on offerings and via our ATM and our DSPP programs.

We greatly appreciate the continued confidence and support our investors have demonstrated in management and in our approach to the business.

Now let's turn to slide 5 and look at what happened in the mortgage markets during the quarter.

As you can see in the top two panels on the left, interest rates rose during the quarter with the five-year part of the curve underperforming.

If you look at the changes in swap rates, two-year and 10-year swaps increased about 20 basis points while five-year swap rates popped almost 30 basis points.

Now let's look at mortgages.

On the bottom left, you can see that lower coupon 30-year mortgage prices declined over 1 point while higher coupons fared considerably better, with a 6% coupon actually up in price from year-end.

In 15 years, shown on the top right, the picture is better as the price declines on even the lowest coupons were relatively modest given the increase we saw in rates.

For example, the 15-year 4% coupon, which best approximates the average of our portfolio, declined only $0.33, which was considerably better than what we saw in the 30-year market.

Now, this outperformance of 15-year mortgages and higher coupon 30 years definitely bolstered our book value during the quarter.

Also of note is that the relative outperformance of 15-year and higher coupons and IOs has continued in April as well.

Now I will turn the call over to Chris to give you an update on the changes to our portfolio starting on slide 6.

Thanks, Gary.

As you can see on slide 6, we maintained significant portfolio diversification while growing our asset base with the equity raised during the first quarter.

Throughout the quarter, we found that risk-adjusted returns available in the fixed-rate market were significantly more attractive than those generally available within the ARM market.

More specifically, as we mentioned on the last call, we preferred certain types of 15-year passthroughs as well as seasoned higher coupon fixed rates.

Now, while there are clearly sectors where we are more active than others, the pie chart shows that having opinions on relative value does not necessarily lead to significant concentration risk.

As you can see, we retained relevant representation in the portfolio throughout the agency mortgage market.

By sourcing the most attractive securities across a range of different types of products, we cannot scale without sacrificing performance.

The prepayment speeds in the table at the bottom evidence this point.

On average, our portfolio prepaid at 13% CPR for the quarter and the April paydown came in at 11% CPR as higher rates are now largely reflected in the speeds.

But to achieve good prepayment results in periods like what we experienced in 2010, you have to go beyond just buying products like TBA 15-year passthroughs, higher coupon fixed rates, or ARMs.

The vast majority of our analysis on a day-to-day basis goes into taking individual securities or subcategories of securities where we can effectively balance exposures to both pre-payments and interest rates.

Let's turn to slide 7, where we can give you some illustration on this.

On slide 7, you will notice that around 70% of our 15-year portfolio is backed by pools with small loan sizes.

We do not just simply wave in the newest generic TBA pools, which tend to have high loan balances that will end up being problematic if rates fall again.

So why do we focus on pools backed by small loans?

Well, the fixed costs for appraisals and settlement fees associated with refinancing are much more of a hurdle on a small loan than a large loan.

Additionally, brokers and originators focus d their attention on larger loans.

Why work on $400,000 loans when you can refinance one $500,000 loan and make the same amount of money?

This translates into prepayment protection for the investor.

If you have any questions on just how important this can be, look back at our Q3 2010 earnings presentation where Gary reviewed how these loans have performed.

In addition to low loan balance, we also look for other characteristics such as 10-year securities, pools backed by less ruthless or efficient originators, and pools with [seasoning].

Now, within the 30-year sector, seasoned higher coupon pools backed by loans with less pristine credit also provide similar advantages.

For example, more than 50% of our 30-year holdings are backed by loans originated in 2010 and prior.

These securities generally offer both pre-payments and extension protection.

The extension protection comes from the higher coupons and the shorter remaining terms as the loans are now essentially between 20- and 25-year terms and can be thought of as being halfway between a 15-year and a new 30-year mortgage.

Importantly, higher coupon market values tend to react less to rising interest rate changes because prepayment estimates obviously fall when rates rise.

Since these securities trade at significant premiums, the benefits of slower premium amortization offset a large component of the market's requirement of a higher base yield.

That's why some of these securities actually went up in price during the fourth quarter when rates rose substantially, and you can see that on slide 5.

Now on the prepayment side, the pools originated in '05, '06, and '07 are likely to perform well because of the combination of weaker borrower credit profiles and today's considerably tighter underwriting standards.

The HARP loans on the table are similar to the high LTV pool that we discussed selling in our third-quarter earnings call in the neighborhood of 2 points over TBA.

But given the backup in rates and less focus on pre-payments, we were able to reinvest in similar types of securities at prices much closer to TBA prices.

And then lastly within ARMs, our holdings include a mix of both new and seasoned pools, many of which have an interest-only feature which further adds diversification and reduces exposure to idiosyncratic risk.

So in conclusion, we've tried to build an asset portfolio with both predictable prepayment behavior as well as manageable extension risks, both of which are big priorities for us.

With that, I will turn it back over to Gary.

Thanks, Chris.

I can't stress enough how important asset selection is to our business.

No hedging or risk management strategy other than an outright ban on interest rates can make up for assets with poor or unpredictable prepayment performance.

But with that said, hedging is critical in this environment and it is currently my single biggest area of focus.

So I will walk through our thought process here in some detail.

First and foremost, at the 30,000 foot level we have to choose whether to prioritize locking in a net interest spread for a couple of years or focusing on preserving book value in the event of larger moves in interest rates.

I want to be very clear here that we prioritize the protection of book value over NIM.

Why?

Because maintaining our book value is essential to running our business and producing income.

If our book value erodes too far, we might need to delever by liquidating some of our assets which could be costly and dwarf any short-term spread income.

Now this doesn't mean we are trying to hedge out all of our book value risk because realistically that's impossible and it's also impractical from an earnings perspective.

Look, we've grown our book value by 11% over the past two quarters and we feel it is okay to give some of that back in some scenarios to balance trade-offs between risk and return.

So to be even clearer, our primary goal is to maintain our book value within reasonable bands under a wide range of interest rate or prepayment stresses.

Now, the good news is that in doing this we also tend to protect significant component of our earnings stream over time because these objectives are not mutually exclusive.

So now while all of this is great in theory, let's discuss what really matters, execution.

So as we've stressed in the past, we use a number of tools to address different components of the risk equation.

First, we have increased our swap book to $15.1 billion or 60% of our repo financing with an average term of 3.6 years.

During the quarter, we added $8.6 billion of new interest-rate swaps with an average maturity of 4.3 years.

While these longer swaps cost more, the reality is that shorter swaps would leave too much book value exposure in many uprate scenarios, especially if the yield curve steepens, which we believe is quite possible.

I am going to skip the swaptions for a second and talk about the other hedge positions at the bottom of the page.

We have discussed the short TBA mortgage positions and the treasuries in the past and today I want to highlight IOS positions.

IOS swaps are total return swaps that essentially replicate the performance of the interest-only strips.

Intersect only strips increase in value if prepayments slow because larger interest payments are received due to the reduction in the number of loans such that prepay.

Therefore, they generally increase in price when interest rates go up and decrease in value if rates fall.

As such, they help to reduce our exposure to rising rates.

At the end of Q1, we had $1 billion in IOS swaps, most of which we entered into during the first half of Q1.

IO strips have performed very well during the quarter as prepayment expectations continue to decline.

Thus these positions generated significant value during the quarter and so far in April as well.

Now, I want to come back to the swaptions detailed in the table on the bottom right.

As of March 31, we had $2.35 billion of swaptions which we acquired at a cost of just over $20 million.

The vast majority or $2.1 billion of these are payer swaptions, which act like put options and give us protection if interest rates rise.

The remaining $250 million is a receiver swaption which acts more like a call option on rates.

We generally purchase swaptions that are out of the money, so they typically will expire without providing any benefits unless we get a decent sized move in interest rates.

But that is exactly the scenario that we worry about.

If interest rates stay relatively stable, our mortgage portfolio should continue to provide strong returns and our book value will likely remain relatively stable.

In the Goldilocks scenario where the Fed remains on hold and long rates don't increase or decline much, I will be a very happy camper and I won't have any second thoughts about having spent $0.16 per share of our book value, which is what the swaptions cost in total to protect against the risk of substantial interest rate volatility.

So please note that our swaption expirations vary over time and our shortest expire in April and our longest and more expensive swaptions don't expire for two years.

If we turn to a slide 10, the graph shows projections of how the market value of our swaption portfolio could change under immediate plus or minus 200 basis point interest rate shocks.

These estimates are produced by the Blackrock Risk Management System.

The system runs all of the components of our portfolio on a daily basis and allows us to analyze our exposure to a host of different interest rate and prepayment stresses.

The return profile of the swaption portfolio is pretty interesting in that we lose a little money if interest rates fall.

However, if interest rates increase substantially, the mark-to-market of the swaptions increases materially.

For example, the swaptions could contribute over $150 million in the up 200 basis point scenario.

Hopefully this graph sums up why we believe swaptions should be an integral part of our hedging strategy.

Look, we know that you are counting on us to manage key transitions in the market that can sometimes be violent, and we do take that responsibility seriously.

Now, if we turn to slide 11, we can quickly review the duration gap of the portfolio.

First of all, we reduced our duration gap during the quarter to 0.6 years via the hedge composition we discussed on slide 11.

Also, notice that we increased the granularity of our disclosure in this area and broke out all the IOS positions I referred to earlier.

I want to remind everyone that when trying to translate a duration gap to an estimate of our book value exposure, you must consider the effects of leverage.

For example, the 0.6 year duration gap needs to be multiplied by our leverage ratio plus the assets funded with equity.

In our case, that number was 8.6 at the end of March.

Now 8.6 times the 0.6 duration gap translates to an estimated hit to book value due to duration alone of around 5% of our equity for the up 100 basis point scenario.

Now, to put this hypothetical 5% hit to book value in some context, that would not even erase the 7% book value gain we saw during Q1.

But again, this calculation excludes negative convexity.

As a reminder, negative convexity is the unfortunate reality that as interest rates change, the durations of our mortgages are not static.

They increase when rates rise and decrease when rates fall.

As such, our exposure to (technical difficulty) moves is greater than what is implied by the duration gap alone.

Now on the plus side, the swaptions and to a lesser extent the short TBA positions are designed to offset some component of the adverse impacts of negative convexity.

Also remember that models used as the starting point for these calculations are based on a lot of assumptions and the results are likely to differ materially from these estimates.

And as importantly, various models and different judgments can produce materially different results, so investors should also be careful about comparing numbers across companies.

So now turn to slide 12 and let's quickly review the business economics.

I'm going to focus on the leftmost column, which gives the numbers as of March 31.

As you can see, our portfolio yield increased to 3.47% due to the combined effects of net purchases of higher yielding instruments and to a lesser extent the impact of slower prepayment projections.

Our cost of funds was 1.05% as of March 31.

This cost of funds number includes our repo costs, our settled interest-rate swaps, and the detrimental impact of $3.7 billion in forward starting swaps that began during the second quarter but does not include the impact of an additional $1.6 billion of swaps that start after Q2 or any of the other hedge instruments outlined on page 9.

With respect to our cost of funds, I should point out that because of the new FDIC charge for banks that went into effect on April 1, repo rates have dropped at least several basis points so far this quarter, which in the absence of any other factors would obviously help our cost of funds.

Now leverage was 7.6 times as of March 31, which was lower than where we had been the preceding 12 months and was largely a function of the timing associated with investing the proceeds of the new capital raises.

Also please note that our total expense ratio has now declined to just over 1.5%, which will provide investors with ongoing operational efficiencies.

So when you put all of this together, you get a net ROE assumption of 20% using the March 31 numbers.

So now let's turn to slide 13 and we are going to quickly review AGNC's performance over the past two years.

Coincidentally, some of you may remember that I started during Q1 2009, so this period now represents eight complete quarters with this new management team.

The graph on the bottom left shows the equity market's view of our performance both in absolute terms and relative to our peers.

And while we knew the general direction of the results, the magnitude is pretty surprising, with total stock returns over 150% during the two-year period.

These results were produced while growing the Company significantly to a market cap of around $3.6 billion where the liquidity of the stock is vastly improved and our expense ratio is less than half of where it was two years ago.

In GAAP terms, our net income has increased from $16 million in Q1 2009 to $133 million this quarter and has averaged $1.83 per share per quarter over that time period.

Quarterly taxable income averaged $1.77 per share.

Now if you had held the stock over this two-year period, you would have received total dividends of $11.30 or an average of $1.41 per share per quarter.

And since our taxable income exceeded these dividends, we have accumulated an additional $50 million in undistributed taxable income during that period.

So as we have stressed, we care a lot about book value, and we are proud to have grown our net asset value by 35% over the period from $19.26 to $25.96 as of March 31.

When you combine the value of our dividends paid plus our growth in book value, you get what we all economic earnings or the bond market's view of the value that we have generated over the period.

The bar graph on the bottom right-hand side of the page shows our performance for the calendar years 2009 and 2010.

Over a reasonable period of time, not just one or two quarters, we strongly believe that this is the best way to compare the performance of the various companies in the space.

But for now, you can feel free to look at total stock return if you want.

Now at this point I want to conclude by reiterating my thanks to the team here at AGNC Management, at American Capital, and the AGNC Board of Directors for their contributions to these results.

I would also like to thank all of our investors for your willingness to support a somewhat different approach to this business and for the increasing confidence you have displayed in us.

We really feel good about our performance during some volatile times over the past couple of years but we do recognize that each challenge is different and our current investors are concerned a lot more about the future and not the past.

To this end, we are continuing to build a larger, stronger, and deeper investment team at AGNC.

And with that, I will ask the operator to open up the lines for questions.

(Operator Instructions).

Bose George, KBW.

Good morning.

I had a couple of things.

First actually on slide 12, I was just trying to figure out where the swaptions -- if you buy the swaptions and they expire unutilized, where does that flow through?

That would come in through the other income line, so it's just basically a realized gain or loss and it flows in through other income.

And so we have clearly had a fair amount of swaptions expire or be paired off.

Obviously some have expired such as in the fourth quarter, we had some expire out of the money and we saw a hit there.

But during the first quarter, we've had a number of swaptions expire or be paired off in the money, so I think you are actually looking at net gains there.

Okay, great.

Then just switching to HARP, I was just curious how much volume do you think comes out of the HARP program this year and how big a buyer is AGNC of the total HARP issuance?

Great question.

Actually, last year when we played in the stuff, it was a smaller market and so at one point we I think owned 40% or thereabouts of the total HARP issuance.

But that market has grown quite a bit and originators are segregating a much wider portion of HARP loans, so at this point that market is actually pretty big and you can buy billions of HARP securities now in a given month.

So we are not a very big percentage of it at all now even though our position is probably the same size as it was last year.

So markets grown we are a small component of that market at this point and I think that's actually a lot of the reason why the prices have reacted the way they did.

Again, as Chris mentioned, I think we sold out of them near up two points.

Now people were really worried about prepayments at the time, so they were paying up for prepayment protected instruments.

Now people don't care nearly as much about prepayments.

I think there is to some degree even some complacency on that front and so the premiums on that type of paper are both due to the mindset on prepayments and because there is so much more of it out there have come way down and the payoffs aren't that significant over TBAs, so we've eventually gone back into the sector.

Great, thanks.

Maybe I will just throw in one macro one.

So do you have a view on the GSEs reducing their minimum servicing fee?

A, do you think that happens?

And B, do you think -- what do you think that does to prepayments?

So first, I think the GSEs do need to and I think there's a clear understanding out there that the current servicing model needs to be adjusted and tweaked.

The most likely thing is a reduction in the minimum servicing.

I really don't feel it's a material impact on the prepayment front.

I am really not worried about it.

If you look at all the other moving parts, they all go actually in the opposite direction such as GSE price increases and so forth.

And so big picture, it probably happens but it's very low on kind of our radar screen in terms of impacting prepayments.

Great, thanks a lot.

Mike Widner, Stifel Nicolaus.

Good morning, guys.

Just had a couple of questions.

First, speaking very high level, I sense sort of -- I don't want to necessarily say change in direction, but certainly more of an emphasis on stability in your commentary and discussion and the protection of book value as opposed to a lot of what we heard over the past several quarters, which was more along the lines of more aggressively taking advantage of the opportunities in the marketplace and so on and so forth.

So just wondering if you could comment a little bit on that.

Is it sort of a different environment that calls for not necessarily a different strategy but at least a moderate change in shift of focus?

Look.

That is a good question and I do agree that the call was definitely centered more around kind of the risk management issues.

We obviously focused on the portfolio as well.

But if you go back to Q4 as an example, the fourth quarter, we saw a big increase in rates and AGNC performed very well.

We had a fair amount of swaptions given the size of the portfolio and we had short TBA positions.

So I really don't feel that this is a shift in mindset in a sense toward being more conservative or being more worried about interest rates.

I think the one thing that is true is that right now the prepayment -- today -- the prepayment landscape is more benign, so by definition, you are going to think more so to speak or discuss more about interest rate risk management.

But there is something to the fact that there's a lot going on in the markets right now and so you have to be cognizant of QE2, all of the other factors, Europe, the Middle East, and what's going on and you do need to continue down the path of optional protection.

So while we might have kind of been willing to back off doing some of those if we felt the market was kind of more benign on the interest rate front, we don't feel that we can kind of back off those types of efforts.

So I wouldn't really say we've kind of redoubled our efforts in this direction.

I think that the clearly more top of mind I think for investors because they are currently worried less about the prepayment front.

That makes sense.

I'm also wondering to what extent if any the larger size of the portfolio -- I mean you guys are up to $28 billion, $29 billion in assets these days.

And certainly harder to find niches to exploit in a way that is material to earnings just as the portfolio gets larger and larger.

So I'm wondering if that kind of impacts your thinking at all?

Actually that's not a big issue because -- from the perspective of risk management, from a couple of perspectives.

Look, there is a difference between running a larger portfolio in terms of some very small trades that may have helped us in the past such as the HARP loans when they were smaller.

We couldn't -- if we were five times as big, we couldn't have bought more of them.

But those are one-off situations here and there, but we are very comfortable.

And I think Chris outlined a number of different things we can do to add a fair amount of value that are very scalable.

And when it comes to risk management, all of our actions are scalable.

We can sell securities in pretty good size.

We can buy swaptions in whatever sizes (technical difficulty) or in incredibly deep markets.

So when it comes to actual we will call it risk management, it is infrequent.

I don't really see the size of the portfolio being a big issue.

In some cases and there are small trades that won't move the needle.

I was thinking more from -- not from a risk management perspective but more from the ability to make needle-moving trades as far as realized gains in earnings and that sort of thing.

In a couple quarters when you're bigger than Annaly, it's probably going to be harder I would suspect to find those niches where you can get needle-moving trades that are going to generate $0.10, $0.15 of earnings, that kind of thing.

Yes, look.

Again, the mortgage market is a huge market.

We're talking about agency mortgage markets over $5 trillion and basically 90% to 95% of everything being produced is coming in through agencies as we talked about in low loan balance, and HARP loans at this point, in seasoned mortgages that we have been buying, some of which are coming out of treasury.

There are -- there is availability of trades that make a difference and we are still very focused on finding those.

You can still find them in size as demonstrated by our portfolio.

If I could, just one other one.

I appreciate those comments.

You talked I think it was back on page 11, you did some quick math and kind of got to an estimated impact on book value of a 1% rise in rates.

I wasn't sure I entirely tracked how you made the connection from the 0.6 net duration gap into the 5% book value impact of 100 basis point move.

Sure, I wanted to go through that because I think we want to make sure people understand this, which is the best -- the 0.6 duration gap is essentially on the assets, but to translate it to exposure to book value, you have to basically multiply that by leverage and our leverage was 7.6 times.

But you also have the exposure on your actual equity, so you actually have to add 1, essentially.

If you take the 7.6 to 8.6.

You multiply 8.6 times the 0.6 and that's what got to about the 5%, okay?

So that's how we did the math.

And again, that's just for duration and excludes convexity and it sort of just -- it's sort of a very short form way of doing -- of looking at that.

I would point people to our Qs and Ks where we actually give you kind of a model run that will include more including convexity and you can in a sense look at some of the other factors that way.

Got you, okay.

So I tracked you up to the 8.6.

I guess that back of the envelope of multiplying the 8.6 times the 0.6 duration gap is not one that I've seen before.

But I guess you are suggesting that's a reasonably --

No, the 8.6 essentially is just the leverage, so if you are -- essentially if the 8.6 is assets divided by equity and this is a duration gap on assets, so if you want to kind of know the exposure to equity, you have to go through that math.

So just simply if our leverage was -- our leverage, full leverage assets over equity was 10, it would be 10 times 0.6 or 6, so that's the math.

Again, it's not a perfect calculation.

It's just a shorthand way of trying to translate that.

Yes, so basically the 100 basis points times the duration gap times the leverage, etc.

Okay, interesting back of the envelope.

Anyway, thanks.

I appreciate the comments and the color.

Mike Taiano, Sandler O'Neill.

Thanks.

Gary, could you just clarify them on the cost of funds calculation, the 105 basis points?

Does the premium that you pay for the swaptions, does that go into that figure at all or no?

No, it doesn't, so the swaption premium, the $20 million again, which includes options that are shorter and options that are longer is not in the cost of funds number and essentially we will be realized in GAAP based on the mark-to-market on a quarterly basis.

It has shown up -- basically we have shown you in the prior quarter and this quarter it shows up in the other income line, which is the change in mark-to-market.

Historically, I think those have clearly netted to a positive number, so if you actually were looking to kind of expense them, you would be figuring out how to expense a positive number through there.

But our mindset is we look at the swaption portfolio and say we are putting out a fixed cost which is not a big number.

We've got lots of in a sense protection for that and we're willing to spend a little of our book value gains.

But net-net, if you -- when you think about that cost versus actually the other income we have generated, you can also think of redeploying the other income into some protection that could pay off in extreme scenarios.

Okay, in terms of the CPR assumption, the decline to 10%, could you just remind me, is that purely formulaic or is there some subjectivity involved in how you come up with that number?

It's no subjectivity or negligible subjectivity or subjectivity in anything.

But we use as the main driver an external model.

Basically it's Blackrock Solutions suite of products and it has prepayment models built into it.

It looks at the yield curve, in particular the forward curve, and that is the driver of our change in speeds.

So it is not a situation where Chris and I go and look at it and say, okay, we think we are comfortable with 10.

Now there are times where you will look at the model and Blackrock will make a change to the model and just some product that you might ask a question about and check, but anytime there's an exception made, it's reviewed with our external auditors and those kind of things are very infrequent.

Thanks, great.

And then just a last question, I guess a few weeks ago your management company filed to create an entity, an IPO for an entity that would buy both agency and non-agency securities.

I was just curious, I don't know how much you can talk about it at this stage of the game, but to the degree that potentially creates conflicts as to what goes in your portfolio versus theirs, could you maybe just address that and sort of how we can get comfortable with that?

It's really not something I can address at this point.

The only thing I can say is we are completely comfortable that the management of the agency irrespective of any endeavors we will do in the future or will continue to be done at the highest level and there will be more than sufficient resources dedicated to maintaining agencies before trying to maintain agency's performance as it has been in the past.

Great, thanks a lot.

Douglas Harter, Credit Suisse.

Thanks, I was just wondering if you could talk about your appetite for continuing to raise capital in the current environment?

Look, there's not much I can say that I haven't said in the past around capital.

We look at a host of different factors.

Clearly the accretion is one factor and interestingly as we grow book value even at the same stock price, by definition there is less accretion.

But look, it's the opportunities in the marketplace and it's something that we will consider if we think it makes economic sense.

But there's really not a lot I can say really around the capital-raising equation except that realistically we have achieved some economies of scale already or a lot of economies of scale already.

Our expense ratio has come down a lot and the stock is clearly much more liquid today.

Great.

And then just touching on the hedging, you clearly brought down the duration gap in those risk measures a lot this quarter.

Is that something that would expect to continue going forward or do you kind of feel comfortable running it at these levels going forward?

It's very dependent on market conditions.

I think right now part of it relates to the interest -- really relates to the interest rate environment, the types of assets that we have and convexity factors.

It's a lot that goes into that, and so what I -- we are not trying to target a 0.6 year duration gap and we're not going to try to maintain that.

That's not the way we look at the overall risk picture.

It is more complicated than that.

And so I would say that in this environment, we are very cognizant of interest-rate risk.

We are still very cognizant about prepayment risk and we're going to continue to do our best to basically balance earning attractive returns while maintaining our book value within a reasonable range under stress scenarios.

Great.

Thanks, Gary.

Jason Arnold, RBC Capital Markets.

Thanks for all the comments on the rate hedging in the quarter.

I was just curious if you could also comment on kind of the key drivers between choosing between swaption, a forward starting swap, plain vanilla swap, etc.?

Sure, the swaption, we will start with the swaption.

What we like about a swaption is that it basically has the asymmetric return profile that we showed.

You pay a premium.

You know what you can lose.

You can lose what you paid for it and so that makes up a certain part -- amount of our hedging that we are -- that sort of -- we look at market prices for options, but there's certainly a percentage that we want to have there.

When it comes to how many swaps and what duration of the swaps, there are a number of factors that go into that and it relates in large part to the assets that we hold, not as much our view on the curve.

That's a little bit of a factor, but we are really again trying to protect book value risk and that drives kind of the maturity or the start date of the swap.

In some cases, the timing of the swap, so also kind of relates to the expiration of other swaps.

So we clearly have some swaps expiring this year.

I think it's $750 million.

We have another $750 million next year, and so we are also thinking about do we want to just sit there and wait until a swap expires to replace it or whatever, or do we want to quote get ahead of that, which isn't probably the best term, but people look at it that way.

So there's a lot of moving parts in that equation.

I do want to be clear that we like as in the case of the assets, we like diversifying our hedges as well.

And we can sit here and talk about how good IOS are and how they've been a very good [fray] so to speak for us or strategy over the last three months, but we don't want to have a massive IO position and use that as our kind of main hedge.

We like the idea of spreading our hedges out where we pick up different benefits, we can hedge out different risks, but if something doesn't work, your exposure is limited.

Excellent.

Thanks for the commentary and great job again this quarter.

Thanks, I appreciate it.

Henry Coffey, Sterne, Agee.

Good morning, everyone.

Let me add my comments, too.

It was a great quarter.

If I am doing my sums correctly here based on some of the data you shared with us, end of period ROE of about 20% on your existing equity base puts us at about $1.30.

If you -- should we assume that that -- if you deploy, you also have on your balance sheet though some unfunded bonds coming your way.

If we add those into the equation, do we ultimately get a higher ROE out of this analysis or did you factor that in?

Henry, we typically don't try to project our ROEs and give guidance going forward.

But look, you're talking about all the relevant pieces, right?

So you obviously have to look at our cost of funds.

You have to look at what our assets are and the ones that are settling, and any new purchases, any change in leverage, any changes in the types of assets.

So while I think we all wish it were as simple as just take all of those things, there are moving parts in the market as well.

So you've got all the right building blocks and we will see how everything falls into place.

But at 3/31, you were earning about $1.30 plus a share?

That's my analysis.

You don't have to agree with it.

Is that an important benchmark to you?

You reported operating results of $1.30 this quarter.

As you look at equity issuance, other capital plans, how critical is holding the $1.30?

What -- when you look way down the pike, what kind of dividend expectation should we set for ourselves?

Actually I got this question I think on the last call and I do want to be clear about this.

Look, we don't have -- we are not running the business to generate a particular dividend or a particular spread.

We look at the opportunities that are in the market and the risks that are in the market and our mindset is more to opportunistically take advantage of those.

So as market conditions change, look, this ROE is obviously an attractive number.

If market conditions change and it's not there, then it's not there.

And we will manage our portfolio intelligently to extract a very reasonable amount of value.

And so I just don't want to give any particular kind of guidance around that.

We've told you kind of all the building blocks and you have the history of how we have managed things in the past.

I would use those as guides, but we are reactive.

We care about how the environment changes.

Well, excellent results so far, so we look forward to more in the future.

Thank you.

Jim Fowler, Harvest Capital.

Hello, Gary.

A quick question on your IO position.

Could you contrast the use of the IO swaps versus just a trust IOs?

Sure, look, we would rather actually use the trust IO and other kind of regular we will call it specific IO securities.

The reality is they are not available in nearly as much size and in the same liquidity, so we tend to initially put on IOS swaps because you get the same basic economics with more liquidity, but over time, we tend to look for value-added IO strips, regular IOs, and we swapped into them.

So we are very comfortable with that position in both of those types of vehicles.

It just relates to availability and liquidity.

Are you starting to see any excess servicing trade with the consideration of Basel III?

(multiple speakers)

We expect to see more of it.

But interestingly, as all -- a lot of people were afraid that IO prices would be hurt by servicers having to sell servicing and excess servicing and while we have seen some come out, all we have seen is IO prices tighten.

So we think people are sort of over -- are overly focused on that dynamic right now.

Is there the potential for a lot more supply?

Yes.

There's a lot of demand in the market, and so it's something we think about.

It's not our highest concern.

Daniel Furtado, Jefferies.

Gary, thanks for taking my call and congratulations as well.

I just kind of want to get -- you were spot on on the buyout issue last year and I just kind of wanted to get what your crystal ball is telling you for the potential for the Fed to sell their portfolio of agencies and what you would expect the market reaction to be to anything along those lines?

You know, I don't really think that the Fed is going to sell their agency holdings.

They are paying down actually at a reasonable clip.

That is slowed down obviously as rates have backed up.

But the position itself liquidated and right now they are still buying -- they are is still actually adding obviously via QE2.

That's widely expected to stop.

The next thing, the next question is do they continue, which they were doing before they started QE2, reinvesting the paydowns and the mortgage portfolio into treasuries and their treasury maturities.

I think they will stop reinvesting as an intermediate step before they actually look at selling.

My guess is they will also wait until the treasury is done selling their portfolio of the next year, which is much smaller.

My guess is they wouldn't kind of double-team the market, so to speak.

Look, if they were to start selling mortgages, mortgages will cheapen up.

I don't want to sit there and say that prices and spreads won't widen.

I think the Fed is very cognizant of liquidity and so I think what we would see is mortgage prices cheapen, but not in any ridiculous way because then by definition the Fed would slow down if they were hurting the liquidity of the market.

So it's definitely something we think about.

We don't think it's going to happen any time soon and if it does, look for pressure on book values, but better opportunities.

Think it's manageable, so to speak.

Got you, thanks for that.

And then I know the question has been asked, so maybe I can kind of frame it in a different way.

It was an active quarter for you, obviously basically doubling the size of your equity base.

You know, you've been trading more or less at one to a book for the last nine to 12 months, you know.

So there wasn't really real pop in the stock in order to kind of trigger that.

It looks like the spreads on investment are slightly above where they were or kind of in line depending on go forward CPR assumptions for new investments.

I'm just wondering kind of what was the -- what was unique about this quarter that made the management team say this is the quarter we should be aggressive?

Not that anybody has a problem with it, but I'm just trying to get kind of what you're seeing out there?

There must been some type of opportunity that made you say let's double the size of our equity base.

First off, I would say we weren't the only REIT that looked at the equity market in the first quarter.

I think last I checked there were a couple other guys.

But realistically, we had a pretty good-sized backup in interest rates and mortgages as they typically do when rates initially move didn't perform that great, so there were good opportunities in particular in the areas that Chris alluded to, which were in 15-year and in higher coupons.

So we had in our minds a very good opportunity to buy value-added shorter duration mortgages in an environment where prepayments were getting easier to deal with, so to speak, with a steep yield curve and good opportunities.

And we were opportunistic about that.

But those are the factors that go into it and we look back and feel very good about it because via those actions, we've got a very solid portfolio.

We have stayed in the products that we are very comfortable with and our earnings stream going forward and our portfolio going forward looks good and we feel good about it.

Excellent.

Thanks for your time and your insights and, again, congratulations on a good quarter.

John Carmichael, a private investor.

Hi, Gary, thanks for taking the call.

I wanted to congratulate you on a great quarter again and your one-year anniversary.

I've been listening to all four of your conference calls and they've all been great.

I really appreciate it as a private investor the detail that you guys provide in your presentations.

It really helps us.

Thanks, I appreciate that.

I had a couple questions.

One, somebody touched on the end of QE2.

I just was curious as to obviously your thoughts as to the impact of what I guess maybe we will find out more tomorrow when Bernanke speaks, but the consensus that he has -- that they are probably going to stop and maybe not sell off anything and maybe continue to reinvest the proceeds and treasuries.

But anyway, there could be a question about whether there was going to be an increase in the spreads, in interest rates, etc.

What is your perception of that if that in fact happens?

What are you guys kind of thinking about in that regard?

I think -- look, there are multiple camps out there.

There was a Wall Street Journal article that discussed two money managers on different sides of that kind of discussion or debate.

Look, we feel that as I said at the beginning of the call, there are a lot of factors going on in the market right now and I think rates -- it is definitely feasible for rates to move in either direction.

QE2 and the expiration is one thing.

I am sort of more in the camp and this was true and we talked about it over a year ago when the Feds stopped by and mortgages, that is more the stock effect and it is more what they have absorbed and what they have bought in the past and less than anything changes the day they stop buying or the week or two weeks later.

That it is a very gradual process.

The Fed has absorbed a lot of bonds, a lot of government-guaranteed bonds.

And so my mindset is the expiration of QE2 is not a -- is likely to happen, but is not like what you create any immediate issues because too many people have set up for it.

And any time investors set up for something in a big way, it usually doesn't happen immediately.

That doesn't mean it couldn't happen down the road.

But on the other side of the coin, there are reasons to just generally feel that especially more medium to longer term rates could move in either direction.

I just want to reiterate what are we doing about that?

We are managing our duration gap.

We are using a variety of hedges, we're purchasing options.

We know it's our job to be protected whichever direction these things go and we can have our individual opinions, but we are not going to bet the ranch on them.

Got you.

I guess my thought based on sort of your answer to the previous question is there could be a move near the end of the quarter or in the beginning of the next quarter where there's some opportunities again for agency REITs to decide that things are cheap on a going forward basis.

Well, as you know, obviously it's our job to be involved in the markets on a daily basis and to look for opportunities and to manage risks.

Last question, I haven't heard anybody talk about, but I guess the thing that seemed to me to be maybe the most immediate potential issue or maybe not, and that's why I'm asking, is May 11 coming up here with the debt ceiling discussions and showdown with the Congress, etc., etc.

I don't have a good read and hopefully maybe you have some thoughts about any actual impact on the GSE's ability to fund mortgages.

In other words, is there going to be any impact perceived or real with respect to short-term financing because of any cash flow issues, etc., etc.?

Look, it's not an area that we are concerned about.

Obviously we think a ton about GSEs and paper and reforms and so forth, but if you think about, you can sit -- we can look at S&P's downgrade of the US Government.

If you think about mortgage backed securities, they have basically a government guarantee and they have underlying loans where the delinquent loans have been pulled out already.

So if you look at it in many ways you could argue they are safer than a treasury irrespective of this scenario because they are a collateralized US Government security.

So I'd keep that in the back of your mind.

The short answer, though, is that we don't expect any interruption to the GSEs because essentially the GSEs have backup lines to the government and they get capital brought in to them as they need it, but that's sort of a -- like that's not an immediate kind of debt ceiling related issue.

It's more over time, so we would actually expect the GSEs to be on the very low end of affected should something kind of go wrong in that process.

Okay, that was sort of my question and I didn't know where they were with respect to funding, etc., but obviously as you indicate, the fact that they are self-funding in certain respects makes them a little bit more safe.

But I just didn't -- because they are running a deficit on most of the stuff that they were still in need of money and they couldn't get funded because of the debt ceiling stuff, that that might cause some concerns with respect to the banks.

But you are tending to think that that won't be the issue at least immediately.

Well, thanks a lot.

I appreciate your

John,

I wanted to say one more thing.

Gary is too modest to make this statement, but Gary is celebrating his second year here, eight quarters of performance, and it's been really outstanding the whole time.

You're welcome to look at the website and look at some of the other earnings calls that he has had.

He has been insightful quarter after quarter.

[Timor Perkin], a private investor.

Good job again.

Another good quarter.

My main question has to do with the synthetic derivatives, the IOS, TRS --?

And I get concerned with this because as you know, during the financial crisis you had counterparty risk with all these synthetic CDOs and derivatives that nobody could actually pay up on.

And I was wondering how you could build a counterparty risk with these IOS, TRS versus just buying an IO strip?

Is it worse or better as far as counterparty risk?

Who are your counterparties and that sort of thing?

Look, that's a good question.

The short answer is it is worse than having an actual security because you do have a counterparty on the swap.

But there is substantial collateralization requirements, so all of these transactions are collateralized and over collateralized, and that's two way.

And when you think about it from that perspective of counterparty risk, there is absolutely no difference from these securities or these swaps versus a regular interest rate swap.

And since we sort of use them kind of in lieu of each other, our counterparty risk is no different, so to speak, than it would be with a regular interest rate swap.

Another key difference there is in the case of the CDOs and some of the more esoteric CDS credit vehicles in the past, the amount that these kind of swaps can move is more analogous to something you would see in a regular interest rate swap versus -- losing 80% of their value and so forth.

So big picture, I wouldn't worry that much about the counterparty issues.

They are collateralized.

Where we look at them in a very similar manner to the rest of our interest rate swaps.

They are just another tool in that area and we are very happy with them.

Hey, Gary.

Why don't you comment on how they perform historically over that last three years?

Well, they have been in existence I think for about a year and a half to two years, but again, it's not really a key issue because of -- during this period, again, they are completely collateralized and because of the fact that the counterparties again all the same ones that are involved in the interest rate swaps.

I see, great.

One other question, I was wondering what the management team has as far as commercial real estate experience.

I know that's kind of off topic, but I'm sort of looking forward to the MTGE IPO.

We're not allowed to speak about anything other than AGNC at this point and AGNC has no commercial mortgage exposure to date.

No, I'm sorry, commercial real estate experience.

I'm sorry.

Sir, we -- that's just not a topic for this discussion.

Okay, okay, no problem.

Thank you very much.

Good job again.

Thanks a lot.

I appreciate the questions.

Matthew Howlett, Macquarie.

Thanks for taking my question.

Gary, just on the long-term speeds taking them down from 12 to 10 CPR, was there any one-time earnings benefit that can be attributed to that or was that just a function of the shifting of the asset class?

It's a little of both, but it was actually I think 11 to 10, so the change in speed was a pretty small impact for this quarter.

It's hard to separate what is due to the -- what's due to change in composition and what's due to the change in the market.

But again, we went from I think it was 11 something --

11.5 to 10.4.

Yes, so we are talking about a 1 CPR change.

So with big changes in CPR, you do get a one-time component, which is technically called catch up [AM].

But that number would be very small in an environment like this where the change in CPR was so small.

Okay, great.

Thanks for that.

Then, Gary, just on the 15-year product, I understand the rationale for building that exposure.

My only question is I guess you just have never seen it used before in the REIT model particularly in front of what presumably could be a rising rate environment.

Do you think you have it better hedged or do you think it's going to actually perform from a duration perspective better than it has in the past?

What sort of -- you reengineer, [reverse engineer] sort of what went on in the last time?

How does that product stand out or how can you use it differently than what we've seen in the past from other REITs?

I think first off, the 15-year product is a pretty short duration instrument relative to other instruments in the mortgage market, so some of the hybrid ARMs, 7 ones and 10 ones, are longer in terms of their interest rate exposure in our minds than a lot of the 15-year coupons.

So 15 year is not that different from a 7 one, maybe somewhere in between.

So big difference -- that's what kind of people think historically about the REIT model, but because of the amortization schedule on 15 years, they shorten very quickly, so it's not a quote 15-year instrument.

It's actually more like in a rising rate environment a four-year instrument.

And if you look at all of the tools we have at our disposal in terms of using interest rate swaps, in terms of swaptions and other hedges that we spend a lot of time talking about today, we feel very good about being able to manage that exposure and I think you definitely see a different kind of hedge book with us and we tailor that to the types of assets that we have.

But we feel that we are well positioned for sizable moves in both directions, and I think a lot of this conference call -- earnings call was designed to really give people the information to make their own decisions on that front.

Okay, fair enough.

Thanks, guys.

All right, thanks a lot and I really appreciate everyone's time.

Thanks, Nicole.

If you could close the call.

Thank you, ma'am.

This concludes today's conference.

You may now disconnect.